Is Borrowing a Substitute for Getting Paid??

Many thanks to the organizers of Credit Slips for inviting me to blog this week.

Henry Ford had a good idea.

In January, 1914 he announced to the world that his workers would be paid five dollars a day. The five-dollar day doubled the average wage for auto workers, produced long lines outside of the factory gates, and helped to create a mass market for the Model T and other consumer durables.

For the next 60 years, this basic formula spread. An entire consumer economy was built on steady middle class jobs that paid slowly rising wages from productivity gains. Wage earners accumulated debts when they were young (mortgages, perhaps car loans, small installment loans for other durable goods), and paid those debts off over their working lives with inflation-discounted dollars from slowly rising paychecks. One was supposed to retire owning a house and not owing the world a cent.

By the middle of the 1970s, this system was fraying at the edges. By the start of the recession in 1981, the patient that produced steady jobs at rising wages was dead. U.S. Federal Reserve Chairman Paul Volcker turned his attention to fighting inflation. Interest rates rose, credit and banking was deregulated, investment became more dynamic, and economic recovery started in the late 1980s. Economic growth through the 1990s and up until 9/11 was very impressive, as were productivity gains in the U.S. economy.

But something was gravely wrong, and by the middle of the 1990s some observers were getting worried.  The economy was growing. Real wages and earnings were not. In fact, median before tax family income in 2001 dollars peaked in 1976 ($42,000) and has been nowhere near that level since. Layoffs, job instability, and family income volatility all rose to near record levels. Yet spending and consumption rose almost continuously from 1992 to now as household revolving debt grew from essentially zero in 1976 to over $9,000 per household by 2005. Total consumer debt outstanding went through the roof and has only tailed off in the past 18 months or so.

Slowly but surely In the U.S. we substituted borrowing and lending for getting paid.

There are a variety of reasons why this happened and I’m not accusing anybody of anything (as Uncle Cecil from Texas would say). Productivity rose in the United States during the 1990s and the benefits of those gains did not filter into most people’s paychecks (They were paid to executives). Financial deregulation (which occurred at almost the exact same time as wages stagnated for the average worker) loosened consumer credit markets considerably and produced a secondary market for securitized consumer debt. Outsourcing, downsizing, and the threats of these put a quiet end to the orderly work career and its steadily rising wages and steady employment. Bankruptcies soared.

More importantly, Henry Ford’s original idea (that workers should be treated well in part because they spend money as a consumer outside the office door) was discarded as a quaint old-fashioned notion.  “Let the other guy treat people well, I can’t afford it” seemed to be the individual response of employers around the country and, for a long time anyway, Wall Street loved it. In the business section of the newspaper major downsizing on the front page was accompanied by major jumps in stock prices on the back page.

Over the long term this exposed a classic public goods problem – U.S. consumer purchasing power is something everyone has an interest in but no one has any concrete incentive to contribute to themselves. There are so many alternatives to paying people a decent wage that virtually any alternative is more acceptable than paying people more money or even paying people what they’re worth.

Is this sustainable?? It is difficult to see how. After all, if someone told you that we were going to base the largest developed economy in the world on (a) treating the mass of employees badly, (b) producing many products and services that are consumed offshore and  then (c) loaning these same employees  money to buy the basic goods and services to keep the entire economy afloat,  I would say that someone just walked off a postbellum Southern plantation to sell us on the virtues of sharecropping(!) . 

The current economic downturn gives us an opportunity to think hard about this entire I-borrow-because-I-can’t-get-a-decent-wage system. Simply restoring the ability of banks to loan money is not enough. Instead, the actual real earnings-based purchasing power of the American consumer must be restored.  This is a much tougher task. Loaning people money is not a perfect substitute for paying them, but it is the easy way out. It produces real differences in political and economic power that can’t be ignored. It also isn’t economically sustainable.

Comments

[lmclark]

Two thoughts. First, you must have been reading my mind. I've been saying the same thing for some time now -- that we've substituted credit for wage increases. It's what makes me very skeptical that we will easily escape the problems we're now in -- I don't see real wage growth happening any time in the future, and I don't see the public able to absorb much more debt. And how sad it will be if we re-start our economy by extending even more risky credit to the American public, sowing the seeds for the next economic disaster.

Second, how odd it is that the first response to your blog was an advertisement for debt consolidation -- as though that's all we need to do to "fix the problem."

[Androcass]

Former Secretary of Labor Robert Reich has a related post on this topic (http://robertreich.blogspot.com/2009/07/when-will-recovery-begin-never.html), suggesting that we are not going to "recover" from this recession. There are those of us who have been caught up in these troubled times who understand this, that our previous economy isn't going to come back, as it was built on nothing, and the rules have changed.

It's interesting ("good" is definitely not the right word) to see others finally picking up on this, but the regular talking heads are still a long way from seeing just how different the world is now. As such, we're unlikely to see any steps taken in a positive direction any time soon.

[JoeP]

Two thoughts as well. I am not sure that U.S. consumer purchasing power is a "public good" in the traditional economic sense, and would love to hear other people's thoughts on this.

It's unfortunate, but I don't think we can realistically think about going back to the Ford model. In this world, there is a global price for unskilled/semi-skilled labor. A company that pays more than that price has an unsustainable cost structure and that business will fail.

[mt]

1) I don't see how you can write that post without using the word "globalization" which is the cause of all the bad things you've described.
2) The phrase "producing many products and services that are consumed offshore" is confusing and I think you intend "consuming many products and services that are produced offshore".
3) I think it is an overgeneralization to say that for 60 years wages slowly rose due to productivity gains, in that it wasn't that smooth and there were other causes for sure.
4) I don't think one can extrapolate the practices of one hugely successful entrepreneur, Henry Ford in your example, to the rest of the economy. Google and Walmart are both hugely successful business models but compensate their workers very differently.

[FrankT]

Henry Ford gave them an increase to $5/day in 1914? And the CPI for 1915 to 1920 took how much of it away? The CPI for that period was downright scary.

[FJP]

FrankT, agreed that the $5/day pay was not a purely altruistic move (with Henry, nothing was) -- and later on, Ford was one of the more notorious union busters. However, the price of a Model T dropped from about $440 in 1914 to about $300 in the early 1920's. And that $5/day came without any significant federal income tax at that time. At $5/day, a Ford worker needed to work 60 days to buy a $300 car. Today, if you consider that even a relatively modest new car can cost $20,000, and if you assume 250 workdays in a year, a person needs an annual gross income of $83,000 to earn enough, before taxes, in 60 workdays to buy a $20,000 car.

[steve from virginia]

Turning America's workers into wages slave was indeed a bad idea but what other choice?

The profile of energy price increases and volatility accompanied this trend. As energy prices rose steeply from the late 1990's 'offshoring' and outsourcing intensified credit demands and gave us bubble- mania!

Obviously, businesses cut their own throats by firing their customers and handing them credit cards as they cleaned out their desks. It was - and still is - an expedient. The hope has been that some savvy central banker could come up with a substitute for cheap crude oil.

The best they could come up with was cheap money ...

The real issue is the industialization - economy of scale - valued added paradigm. Commercial production of goods and services was low cost, due to inexpensive energy inputs. No longer, the value added part is being crowded out by ever increasing fuel prices and the result is the bankruptcy of the entire industrial method.

I know this is not fun, but when you drink up all the booze you cannot get drunk any more and that is where we are today. We've drunk ourselves into an uncertain sobriety.

[E.L. Beck]

Great work - A point I made last December in a post:

http://www.the-small-r.com/the-small-r/blog/Entries/2008/12/8_Entry_1.html

[Pete Dooley]

I began manufacturing in 1971, added retail in 1981. I have felt and seen step by step each date and time span you have explained so well here. Henry ford was a study (manufacturing not splitting union workers heads).

The products we once produced here (USA), with twelve employees, are produced overseas, or virtually donated to retailers with unlimited credit terms at a loss, by companies funded by stockholder monies. Our once booming retail store is closed. Our customer base, systematically reduced to rifling through five or six credit cards over the last few years to make a small purchase, dwindled and dried up.

I have been through numerous bank closings and "mergers" over this time span, there is only one bailed out banking concern in my town now. I have to travel to a nearby town to access my bailed out banks "services".

From the seventies to the eighties my business doubled yearly until I was one of the top companies in my field. From "91" on it has been a slow painful decent into nada.

I see now no one necessarily "moved the cheese" rather the whole table the cheese we rats were on has moved, and its legs are wobbly. I wish your precise explanation was available as a forewarning available around 1991 rather than a definitive report in 2009. Thanks anyway. Brilliant